News:

The Book of the Diner is well worth preserving. I only wish it had reached a broader audience when it might have mattered more. That is a testament to the blindness of our culture. If there is a future to look back from, one difficult question historians will have to ask is how we let this happen, when so many saw it coming. This site has certainly aggregated enough information and critical thinking to prove that.[/b]

Since last year real GDP growth in the U.S. has been slowing. The chair of the Federal Reserve has been signaling that while growth is slowing, there is no recession risk and the Fed is forecasting continued positive growth. Warning signs in the economy, including an inverted yield curve, have been ignored and stock markets continued to make new highs in July. In August a correction took a place and subsequently a rally ensued into early September. On September 18 the Fed cut rates.

Sound familiar? It fairly describes market and economic conditions in the U.S. over the past couple of months. Except that this paragraph would be as true for the U.S. economy and stock market in September 2007 as it is today. Consider that 12 years ago the yield curve was inverted and U.S. economic growth was markedly slower than it had been in 2006. Yet the Standard & Poor’s 500 SPX, +0.03% made a new high in July 2007 (same as 2019), there was an August correction (same as 2019), and then the Fed cut rates on September 18 (ditto — same day even).

U.S. stocks proceeded to make another marginal high that October — and that was it. Lights out. We all know what happened next.

It seems we are at a curious moment in time. Parallels to late 2007 are running through the markets now. This doesn’t mean the market’s fate will play out as it did then, but the ingredients are there and all that’s needed is a trigger. Perhaps the trigger was the attack on Saudi oil installations last weekend. It’s too early to tell, but clearly this is something to keep in mind.

XSee AlsoIndex Funds are the New Titans of Wall Street

Markets topped in October 2007 following the Fed’s September rate cut. That November, Ben Bernanke, then Fed chair, said there wouldn’t be a recession. According to a November 2007 Reuters report, Bernanke told a congressional committee: “Our assessment is for slower growth, but positive growth, going into next year.” The U.S. economy entered recession in December 2007.

Does this not sound eerily similar to what Fed Chairman Jay Powell has been saying? Here’s Powell on September 6: “We’re not forecasting or expecting a recession,” he said. “The most likely outlook is still moderate growth, a strong labor market and inflation continuing to move back up. Our main expectation is not at all that there will be a recession.”

Sure, there are differences between now and 2007, and of course no two time periods are alike, but the confluence of circumstances is impressive. Markets now are behaving in highly correlated ways with 2007, and the Federal Reserve seems to be behaving similarly as well.

Read: The S&P 500 should be 13% lower because a recession is coming

What does all of this suggest?

For starters, the Fed will not tell you when a recession starts. They can and will be in total denial until after the fact. The 2007 recession began one month after Bernanke stated in front of Congress that there wouldn’t be a recession. So when Powell makes the same declaration as the Fed cuts rates again, know that such a statement has absolutely no meaning. “Not forecasting or expecting a recession” he stated on September 6. Is this Powell’s Bernanke moment?

To avoid the same fate, markets now need to make sustained new highs or risk seeing similar circumstances to 2007 play out in similar ways.

Sven Henrich is founder and the lead market strategist of NorthmanTrader.com. He’s known for technical, directional, and macro analysis of global equity markets. Follow him on Twitter at @NorthmanTrader.

WASHINGTON (Reuters) - Tucked into Fed Chair Jerome Powell's news conference on Wednesday was a not-so-subtle message for President Donald Trump: the economy is holding up because the U.S. central bank has acted to support it through a volatile patch, and whether that continues is now in the president's lap.

In a buck-stops-over-there-now performance, Powell indicated that the Fed's two rate cuts this year are likely adequate as insurance against the rising global risks posed by Trump's whipsaw trade negotiations with China, and that going forward the Fed sees little need to move unless those risks materialize in the form of weaker U.S. economic data.

"Trade developments have been up and down and then up, I guess, back up perhaps over the course of this interview," Powell said in a reference to Trump's sometimes unpredictable trade war with China and, on occasion, other countries.

"I do believe our shifting to a more accommodative stance over the course of the year has been one of the reasons why the outlook has remained favourable," Powell said, citing reasonably strong U.S. data. Going forward "we are going to be highly data-dependent" in deciding on further rate moves.

The Fed cut its benchmark overnight lending rate by a quarter of a percentage point on Wednesday, the second such move this year, but new policymaker projections showed no further cuts were anticipated in 2019.

The comments continue a subtle push back by Powell against a chief executive who has used personal insults and a steady stream of Twitter invective to demand the Fed slash rates to recession levels and take other out-of-the-norm steps to boost the economy.

At a keynote speech at a central bankers conference in Jackson Hole, Wyoming, last month, Powell said the U.S. central bank had "no recent precedents" to set monetary policy when the rules of global trade had become so unpredictable and begun to sap business confidence and depress global growth.

The United States, the world's largest importer, has been locked in often contentious negotiations with its top trading partners since the Trump administration imposed tariffs on steel and aluminium imports in March, 2018. The escalating U.S. tariff war with China has shut down Chinese imports of petroleum and many agricultural products, and uncertainty about when trade talks could be resolved is dampening capital expenditure.

The International Monetary Fund said in July that global trade slowed in the first quarter of 2019 to the lowest level since 2012. Tariffs applied in the U.S.-China trade war could shave 0.5% off global economic growth in 2020, the IMF said.

Whether that starts to effect a still-relatively optimistic Fed outlook will depend mightily on whether Trump's trade talks with China end on a note that restores what the Fed said is "weakened" business investment, or leave the world stalled and guessing.

"It is an unusual situation," Powell said. "The U.S. economy in itself is strong. ... The difference here is we have significant risks" that elected officials will have to manage.

Kroszner: Markets Have Fragilities That Nobody ExpectedLISTEN TO ARTICLE3:49SHARE THIS ARTICLEShareTweetPostEmail

The Federal Reserve added liquidity for a fourth straight day to a vital corner of the funding markets, helping further stabilize rates as investors remain concerned that fresh bouts of stress may be felt in the weeks ahead.

The New York Fed injected another $75 billion Friday through an overnight repo operation. That followed operations of the same size on Wednesday and Thursday, and $53.2 billion on Tuesday, with each of these prior agreements rolling off the morning after they’re completed.

The actions, commonplace in pre-financial crisis times, temporarily add cash, with the Fed taking government securities as collateral. Wall Street bond dealers submitted about $75.6 billion of securities for Friday’s Fed action, lower than the previous two days’ levels. Many analysts are already predicting the Fed will do a similar operation on Monday.

“Given it was slightly oversubscribed and the rate was at 1.8%, its shows the Fed is playing an important role in calming the market and needs to keep doing these operations,” said Priya Misra, head of global rates strategy at TD Securities in New York. “But overall, these operations are only a temporary fix, it’s a band aid. The big fear is that around quarter-end, when dealer balance sheets are more constrained that these Fed operations won’t work as well any more.”

The latest addition of liquidity -- with the Fed making clear it’s ready to do more as needed -- follows the Federal Open Market Committee’s move Wednesday to reduce the interest rate on excess reserves, or IOER, by more than their main interest rate -- all attempts to quell money-market stresses.

The operations have calmed the funding market, with repo rates declining to more normal levels after soaring to 10% Tuesday, four times last week’s levels. Overnight general collateral repurchase agreement rates remained steady Friday, trading around 1.9%, according to ICAP.

Fed Vice Chairman Richard Clarida said on Friday the repo market strain isn’t a concern for the economy and that the central bank acted decisively to address the issue. Chairman Jerome Powell said on Wednesday that he was confident the New York Fed’s actions would contain funding problems. Former New York Fed President William Dudley echoed that view in an editorial published Friday.

Click here to read Dudley’s editorial

The Fed effective on Thursday was 1.9% -- within the central bank’s target rate range of 1.75% to 2%. That compares to 2.25% on Wednesday, and 2.3% Tuesday -- when it busted above the top of the Fed’s previous target band, before policy makers lowered borrowing costs on Wednesday.

However, there are signs of investor apprehension about future funding levels, which is manifesting in different ways.

Treasury bill sales on Thursday were met with a poor reception, as investors demanded to be compensated via higher yields for locking up cash. And the rate on two-week repo, which would fund investors through the end of the quarter, is around 2.58%, ICAP data show.

The Fed may conduct term repurchase agreements, with such transactions extending beyond one day, to contain the risk of outsized repo rate movements over the final days of the quarter, said Scott Skyrm, executive vice president at Curvature Securities, a New Jersey-based broker-dealer that focuses on the repo market.

“It’s the right time for the Fed to come in and do a term operation into October, which would pre-fund some cash into the market for quarter-end and take care of some of those liquidity concerns now,” Skyrm said.

Meanwhile, in cross-currency basis -- which shows floating-rate payments in different currencies -- the premium for the Australian dollar over its U.S. counterpart collapsed by the most in eight years during Asian trading hours.

Lou Crandall of Wrightson ICAP said in a note this morning that next week may bring more funding pressures in repo.

“Bill settlements as well as the early liquidity-chilling effects of the approaching quarter-end statement date could start to move repo rates higher,” Crandall wrote.

Is that the shit show turbulence you ordered from the Universe to be entertained up to a crescendo culminating on christmas eve ?

Will we get to test my theory that the System needs its assets forcefully inflated while the real economy atrophies until everyone realizes Capitalism ultimately leads to an unambiguously central planning endgame phase, ...right before collapse ?

I confess, I do enjoy central banker squirming; and squirm, they will.

Why the Repo Market Is Such a Big Deal—and Why Its $400 Billion Bailout Is So UnnervingBy Alexander Saeedy

September 23, 2019

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One of the most vital pieces of plumbing that powers the global financial system usually runs so smoothly that it gets overlooked by market watchers. It’s the “repo market,” comprising the short-term funding that banks and financial counter-parties regularly tap to lend each other trillions.

It’s suddenly in the news again, and for all the wrong reasons. The repo market is looking a lot like it did on the precipice of the 2007 housing market crash.

But what is the repo market, anyway, and why has the Federal Reserve Bank this week injected hundreds of billions of dollars into the financial system to stabilize it?Paid ContentTackling Plastic Waste for a More Sustainable WorldFrom HP

Repos (short for repurchase agreements) are short-term borrowing transactions, often made overnight. Think of them as trades of cash for some kind of collateral.

In a repo transaction, the borrower will sell certain securities in their possession with the agreement to buy them back the next day. If the transaction is not rolled over, then the trade has to be settled the following day, with the borrower repurchasing the collateral from the lender for slightly more than it had previously sold it for, compensating the lender with interest for taking on the risk.A $1 trillion market springs a leak

Large corporations and banks typically hold vast quantities of highly liquid financial assets, and so they like using these markets as a means of quick and easy financing. In fact, there are more than $1 trillion worth of overnight repo transactions collateralized with US government debt occurring every day. Banks frequently go to these markets to fund the loans they issue, and to finance the trades they execute.

That’s when it’s working smoothly.

The repo market seized up last week, with median repurchase rates skyrocketing from their usual band of 2.00-2.25% to 2.46% on Monday, and 5.25% on Tuesday. Keep in mind, that’s the median rate. Some repo rates were as high as 9%, more than quadruple the Federal Reserve’s own target rate, which usually puts a cap on how high Treasury repo rates could climb.

An unlucky confluence of events, including an exceptionally large demand for cash from U.S. companies that needed to pay their corporate tax bills, sucked a lot of the available cash out of the financial markets. What happened last week was any counter-party in need of cash, and only holding collateral like Treasuries, agreed to pay the much higher going repo rates. That’s supply and demand, plain and simple, and it mirrors what happened in certain repo markets in 2007 before the housing crash and the Great Recession that followed.

So, what happened to the usual abundance of cash and liquid securities that powers the trillion-dollar repo market?

It’s been slowly evaporating, actually, for some time, since the Fed ended five years ago the policy of quantitative easing (QE), its maneuver to buy highly liquid bank securities to boost overall bank reserves. The thinking (and hope) of that controversial policy was that the increased liquidity would encourage banks to lend more and spur economic growth at the depths of the downturn.

Those kind of accommodative actions have been over for some time now, and total bank reserves have steadily been decreasing. They peaked in August, 2014, and are now close to where reserves were in 2011. One principle reason for that: an elevated level of government debt issuances in the past four years have sucked reserves out of the financial system.

When a squeeze like the one last week occurs it’s a clear indicator that there aren’t enough reserves in the financial system for repo markets to clear at the Fed’s preferred level—in central bank parlance, the “target rate,” or the Fed Funds rate. That explains why the central bank has been engaged in open market operations to inject reserves back into the banking system through overnight purchases of Treasuries.

“The Fed plans to use open market operations to address funding pressures through the quarter-end, and learn more about the adequate level of reserves. We expect it to find the U.S. funding markets in a state of reserve scarcity,” wrote Bank of America economists in a September 20 note.The repo plan: more interventions to come

Even though the Fed has routinely used open market operations in the past to stabilize these funding markets, it doesn’t look like a few routine interventions will be sufficient. Moreover, it’s becoming clear banks need more reserves on hand. On Friday, the Fed pledged to allow roughly two more weeks of overnight repo transactions, each injecting around $75 billion daily into the economy, the Federal Reserve Bank of New York said in a news release on Friday.

Put otherwise, the Fed is back where it was roughly a decade ago, effectively buying U.S. Treasuries from banks on an indefinite basis. But the difference this time? There’s no financial crisis in sight, just the uncomfortable fact that private capital markets once again need public support.

“For all intents and purposes, this will be equivalent to QE, with scheduled purchases of securities. We estimate that over the first year, the Fed would need to buy roughly $400bn of Treasury securities to achieve an appropriate level of reserves, plus a buffer,” the Bank of America wrote in a research note.

The Fed's tightening takes months to start to play through the whole economy.

This week's shock wave is the effect of all that tightening now starting to seriously play through the financial system.

With almost $300 billion in overnight Fed infusions, we haven't seen Fed action on this scale since we plummeted into the Great Recession.

Well, that didn't take long! Four days ago, I stated the following in an article titled "Why are Bonds Going for Broke?":

Central banks are losing control, and are admitting they don't even understand what is happening.

I quoted St. Louis Reserve Bank president, James Bullard, who commented:

"Something is going on, and that's causing I think a total rethink of central banking and all our cherished notions about what we think we're doing…. We just have to stop thinking that next year things are going to be normal."

There is an awful lot of thinking about the need to rethink the way they think in that statement from which I concluded,

The [central] banks appear to be losing control of interest rates and to be, themselves, controlled by market forces they can no longer contain or fully manipulate.

I noted that reserve bank presidents who say things like "something is going on" do not instill confidence that the Fed knows what is going on or how to deal with it, especially when they add that the Fed is "rethinking" how it thinks things work. I suggested the large swings in the bond market this month may be related to problems developing concurrently in our financial underpinnings, now showing up as massive cracks on the surface of the economy all around the economy's fundamental interest rate. That's not good.

Even Wall St. now agrees: The Federal Reserve Bank of New York delivered major jolts of evidence this week that the Fed is, in fact, losing control over interest rates.

[For anyone who doesn't understand how the Fed governs interest rates via repurchase agreements, I wrote the following article as a companion to this one: "BOND PRIMER: How the Fed's Machinery Works." You may want to read it first and then come back here.]Fractures in the system cracked wide open this week

At its last meeting, the Fed's FOMC, which sets interest policy, downshifted its Interest-on-Excess-Reserves gear by lowering the interest it pays banks on their excess reserves. The IOER both entices banks to maintain excess reserves by paying higher interest on the excess than on the mandatory reserves, and sets an effective floor on bank overnight loan interest by establishing a rate the Fed will pay to keep that money in reserves. Banks have no reason to loan their excess reserves to each other for less than that rate because they can get totally secure interest from the Fed at that rate.

Dropping that rate last week accomplished absolutely nothing because banks were already lending well above that rate! An exercise in futility at this point. I suppose the Fed thought lowering the interest it pays on excess reserves would encourage banks to get flush out some of their excess reserves by loaning them to other banks, but that only works if there actually is enough money in excess to make a dent. Apparently there was not.

Throughout the first half of this year, the Fed Funds Rate set a target range for overnight loans of 2.25-2.50% (set at its December 2018 meeting as its last rate increase), and the effective rate for loans cruised smoothly along the IOER floor. (See chart below where "Effective Fed Funds Rate" means the median overnight loan rate that actually happens, not just the stated target.) By late March the effective rate began to bounce above its floor. A hint of a problem but not an actual problem so long as the effective rates stays within the target range, but it shows pressure building toward the top of the range, versus a smooth ride along the Fed's floor. By May it was spiking fairly erratically.

At the end of July, The Fed reset the Fed Funds Rate lower to 2.0-2.25%, and it lowered the floor rate by which I don't mean the bottom of the Fed's stated range, but the IOER it sets, which banks are not inclined to loan below. Rates settled down a little but stayed above the IOER. Then on Tuesday of last week, while the Fed's target range was still 2.0-2.25%, the overnight interest banks charge each other rose above that to 2.3%. During its subsequent FOMC meeting, the Fed lowered its target to a 1.75-2.0% range, but what meaning does that have if the effective rate is already above the old target? For the rest of the week, the effective overnight interest rate kept bursting above the Fed's bounds, raising questions all over Wall Street about whether or not the Fed had lost its ability to establish interest rates, even at the most foundational level! At one point, the rate went astronomically higher, skyrocketing to 10%!

Obviously, it is meaningless for the Fed to change IOER or set a lower target for its Fed Funds Rate if it cannot manage the interest banks are charging each other to stay within its target range. As I've noted in previous posts, particularly Patron Posts where I've been following the Fed and other central banks in greater detail, the Fed appeared to have been wrestling all year with trying to hold interest in its target range, given the effective rate's choppy float above IOER.

Here is a picture of what happened this year where the "effective Fed Funds Rate" is the rate that actually happens versus the rate the Fed states as its target. The difference between that effective rate and the interest the Fed pays on excess reserves jumped up like this:

Zero Hedge

The yellow line represents the level at which the actual interest banks are charging for overnight loans matches the current IOER (zero difference). You can see that the overnight interest rate was trundling along that line of demarcation until late March of this year. Then pressure started forming above IOER as bank reserves were dropping until this week it went ballistic!

So, tell me the Fed has control of this when it has been clearly struggling with control to an increasingly greater degree for much of the year! It was at the start of January that I first pointed out in a Patron Post this building pressure toward the top of the Fed's stated range and indicated it would likely become the key critical event of the year.

You can see in the following graph that the intraday high in the overnight funding rate was truly historic:

By looking back to find the periods this historic high actually managed to beat, you can see why this event rang alarm bells all over Wall Street. I betas two former crises. Nothing touches it. However, the Fed gave all the concerned people on Wall Street the placid straight-faced assurances they wanted to hear, so everything is fine now. Pathetically, the mainstream media, as I'll point out below, seems entirely willing to believe that as if it has never recognized the truth of the first graph above, which shows interest has been pushing the outside of the Fed's envelope all year.

This past week cracked everything wide open. Sometimes a spike in the overnight loan rate happens at the end of a quarter because there are so many transactions in the last day or two of the quarter so that banks are more likely to need to borrow from each other. You can plainly see, however, those spikes are minute compared to this one. This was not just an end-of quarter phenomenon but is the crescendo of a situation that has been bumping the upper bound for months until it pounded its way out, and the situation is still playing out several days later. Besides, we were two weeks from the end of the quarter when all hell broke loose.

How bad was it?Day One - Repo One

On Tuesday, the NY Fed had to leap in with over $50 billion in overnight Repos, in which it injects money directly into the economy for a day by buying treasuries from banks with the agreement that banks buy them back the next day. That was the NY Fed's first major transaction like that in more than a decade! As interest shot up, the NY Reserve Bank punched it down by creating $50 billion in flash cash out of thin air. This is similar in size to quantitative easing. For an accurate sense of scale, it is the same amount the Fed was taking out each month during quantitative tightening, except the money created is just temporary. It goes into the system one night to relieve stress and is paid back and deleted the next.

Bloomberg described the drama of Tuesday's thrill ride this way:

Up and down Wall Street, phones lit up Tuesday morning as a crucial market for billions in overnight borrowing suddenly started to dry up. What had begun on Friday, with tremors inside U.S. short-term funding markets, was escalating rapidly….

Not since the 2008 financial crisis has a spike in money-market rates caused such a stir - or prompted such a response….

From New York to Chicago to Los Angeles, major banks, corporations and investment firms struggled to get answers about what is usually a simple question: Where is the overnight repurchase rate, the grease that keeps the vast global financial system spinning? Rumors flew. Wall Street dealers scurried to protect their clients - and themselves….

By 10:10 a.m., after an initial, embarrassing misstep, the Fed was pumping $53.2 billion into the market to calm nerves and regain control over interest rates - its first intervention since the dark days of Bear Stearns, Lehman Brothers and the rest. Bloomberg

It was a big deal with ominous overtones, and the buffer the Fed created in response looked like this in terms of how the various transactions during that twenty-four hour period impacted the repo rate:

Bouncing everywhere. Clearly, the NY Fed never did get interest rates down to its target range. The NY Fed kept slamming them down, but the next day they shot right back up.

Of course, as Bank of America's Mark Cabana purportedly said, one day is not a big deal; but if funding pressures persist, it implies a loss of control of funding markets.

Well, then, day two:Day Two - Repo Two

Funding pressures did persist. Since the NY Fed's cash creation failed to meet demand, they had to jump and pump again - this time with 50% more new flash cash!

Another thing I've stated for years is that, when the Fed finally did try to tighten, its tightening would crash its recovery. From there, its effort to recover its recovery would all play out behind the curve. So, here we are with the Fed rushing in to catch up on the accumulated damage (but still not doing enough).

My basis for that prognostication was primarily the Fed's track record. I find history is one of the best predictors of the future because human beings love to repeat their mistakes. The Fed always tightens us right into recessions. So, with the greatest "post-recovery" tightening in Fed history, why would we expect anything other than the Fed being further behind the curve than ever before? This is something they never get right, as even the Fed has admitted.

Day Two presented solid evidence that the Fed is solidly behind the curve, for this was the day when a NY Fed Repo operation the size of previously monthly Fed quantitative tightening didn't do the trick, so they amped up to a Repo operation nearly the size of the Fed's previous monthly quantitative easing - $75 billion! And that didn't do the trick!

For a second straight day, the Open Market Trading Desk at the Federal Reserve Bank of New York will conduct an overnight repurchase agreement operation from 8:15 AM ET to 8:30 AM ET on Wednesday, Sept. 18, to help maintain the federal funds rate within the target range of 2.00%-2.25%. The repo operation will be conducted with Primary Dealers for up to an aggregate amount of $75B. Seeking Alpha

(If you try to calculate how these overnight loans tally up, bear in mind they are literally just that - overnight and then gone. That means much of the $75 billion may have gone to refinancing the previous night's $53 billion. That's impossible to know because the details are not available. It could have, on the other hand, been all new banks coming in with a cash shortage, even as the previous night's banks got their funds together. It is probably mostly the former and little of the latter, but who knows, except the cloaked Fed?)Day Three - Repo Three

Sure Day Two failed, but remember, "one day is not a big deal;" it's only a big deal "if funding pressures persist." In which case, "it implies a loss of control of funding markets."

Both days failed, because the NY Reserve Bank's operation, scaled as it was to the size of monthly QE3, fell short of funding needs, causing the Fed's overnight rate to remain far over the Fed's target.

And then Day Three failed.Day Four - Repo Four

More of the same. Nothing more to say here.Day Five - Repo Five

Ditto. Except, Powell says more. He says a lot more injections are on the way. Along with his calm little speech on Day Five, by which time Wall Street was getting seriously worried, he presented a new Fed schedule to calm the hive (first of its kind) for the future injections.

I say, "No end in site." I say "economic crisis." Bank of America said its "only a big deal if the problem persists." Then, I say "big deal" because it's persisting; the Fed's new schedule shows the Fed believes the problem will persist for about a month … and even hints maybe longer.Cracks burst open due to prior months of tightening

The likely cause of this mayhem: Liquidity among banks seized up so badly that rates shot up. That was my overall opinion at the start of the week as I was waiting to see if the first event was a one-off and how the week stacked up before writing about it.

There could have been other causes, of course, such as a big Lehman-style event busting open behind the scenes that scared banks from lending to each other while everyone remains silent about it. Such perfect silence seems unlikely. By the end of the week, however, I felt confident that tightening liquidity throughout the financial system was the source of the problem because I saw that had become the prevailing opinion and was even described as part of the problem by the Fed, and that's what I had been anticipating all year.

The situation that exploded, according to numerous financial publications, was a combination of new government debt (now that the debt ceiling has been lifted), stacking up against a short supply of reserves in banks for soaking up that debt while those banks also carried out other large end-of-quarter tax transactions that happened at the same time. It wasn't just the sudden new issuance of government debt after the debt ceiling was lifted because government debt auctions have actually gone pretty well so far this month - no scary anomalies showing up there … so far. That was a contributing factor, but a confluence of funding needs overwhelmed thinning reserves.

The importance of pointing out months ago that this was coming and pointing out that it was pointed out is that it leaves the Fed with no excuse for not seeing it coming. They are supposed to be the experts in this field. My statement that it was going to happen was based on simple logic about how the Fed's tightening was taking down bank reserves. That was happening because the Fed was leaning on its member banks to buy and hold US treasuries in order for its tightening not to drive government interest dangerously high. (If member banks cannot resell those treasuries but keep them off the market, then they cannot replenish the reserves they transferred to the US government's own bank account at the Fed (the Fed being the government's banker) when they bought those treasuries. As a result, the aggregate of reserve balances held by the Fed's member banks, has done this:

Monday Morning Macro

That's also a big factor in why I've said we will see recession starting (this summer in my stated opinion). The Fed's tightening (see above graph) takes months to start to play through the whole economy. Thus, I believed we would be seeing this summer the results of the quantitative tightening the Fed did up through December, but the Fed kept tightening all the way through July, so there is much left to play through.

This week's shock wave is the effect of all that tightening now starting to seriously play through the financial system. From there, it impacts the economy to more noticeable degrees. It is the effect of the diminished reserves in the graph above just as the government has lots of treasuries to issue, which member banks have to soak up, leaving no room for other major transaction impacts.

How large was the quake that created these cracks? As stated by a trader who has spent most of his career working at the low end of the yield curve (where the Fed Funds Rate is most effective):

Suffice to say, we're not supposed to be talking about $ funding markets - the linchpin of the largest & most important … market in the world, US Treasuries - in the same breath as the wreckage wrought in Argentina only a month earlier. We're definitely not supposed to be saying "the collapse in the Argentine Peso was barely 1/3 of what we just saw in the market that the Fed controls…" Monday Morning Macro

O.K. We're not supposed to say it, but he did, and then he said more:

What was a perfectly mundane combination of factors quickly spiralled out of control due to much more sinister structural issues….

Those structural issues are primarily those declining reserves I and ZH and a few others were warning about, which the Fed has argued all year are not a problem.

The debate became over that minimum acceptable level of reserves & showed up in talking points by various Fed officials as a question of "reserve scarcity". The overwhelming response from the Fed, despite all evidence to the contrary, was that there was no problem…. It strains credibility to believe that senior Fed officials like Potter & Logan didn't see there was a major brewing storm….

It strains credibility, indeed, which is why I point out the problems that will come months before they do (as did some others) just to make it clear the Fed has no credibility. I do it to stab in the heart their foreknowable excuse that no one could have seen this coming. Maybe the Fed doesn't see these problems coming. It doesn't even appear to see them clearly now.

That leaves you with two options: question the Fed's ability in the area of its supposed expertise and explain how smart people can be so dumb on the basis that their collective mind is clouded with wrong philosophies, or entertain any of several conspiracies that the Fed is playing dumb while it intentionally breaks the system. I'm in the former camp; but, either way, the storm is here and it could clearly be seen coming, whether the Fed is able to see it or not.

On top of that, the vast [government debt] issuance needed to support an unwieldy Federal budget had conspired to drain reserves further…. Banks were holding a quarter of a trillion more Treasuries than they had in the past…. And recent signs that all was not well with the funding market was [sic.] evident in spreads that targeted the front-end of the curve most notably…. I recall being in a meeting in early 2018 with a senior staffer who was asked about why the Fed wasn't more alert to the potential dangers being posed by clear & present reserve scarcity. The (not unreasonable) query was returned by a shrug & dismissal….

And then the trouble began, just as cash was withdrawn from member-bank reserve accounts to buy treasuries, especially at the lower end of the yield curve wherein the two-year saw its biggest sell-off in a decade:

All that was left was a catalyst for things to get really, really ugly. That came when a timed demolition went off on Monday: corporate tax day, an overseas holiday for one of the largest holders of USTs (Japan) & a large "unplanned expense" … plus a massive settlement day for recently auctioned Treasury collateral. Any one of those could push overnight repo rates higher on their own, even during "normal" conditions. Given the circumstances, all of these factors together generated the explosive power of a hydrogen bomb in funding markets. Stripping out year-end turns [such as the similar massive spike seen at the end of last December], this was easily the largest 1-day move on record - exceeding the previous highs that were set during the darkest hours of the financial crisis.

Monday Morning Macro

Clearly, we are not talking a small problem. December's spike was a one-day problem on the final day of the year for all financial transactions to be cleared for the year. It was nothing compared to this. This spike broke higher than December's, and it kept spiking all week with repeated massive attempts by the Fed to bring it under control. Bear in mind this is all in the one market the Fed manipulates most directly and most carefully.

The Fed has indicated it will not likely cut rates any more this year, but what does that matter? If you cannot get your most fundamental interest rate to cooperate with you when you try to lower it, and it shoots to the moon, instead, then your targets become empty words. Sadly, the dull public seems unable to recognize that. More importantly, one should ask how stable is the full economic debt load that rests on top of that benchmark rate? How stable are the institutions that are experiencing this squeeze?

What you should be concerned about more than all of that, however, is Fed Chair Jerome Powell's response in his written speech summarizing the Fed's interest-setting FOMC meeting - yes the meeting in which they set the very rate target we're talking about as a way of stimulating the economy:Powell's babbaloney response to this crisis

Let me say a few words about our monetary policy operations. Pressures in money markets were elevated this week and the effective federal funds rate rose above the top of its target range yesterday. While these issues are important for market functioning and market participants, they have no implications for the economy or the stance of monetary policy.

Powell's response should scare the bowels right out of your body. The Fed Head just noted candidly and with a straight face, as if his words are about to make perfect sense, that interest was already failing to cooperate in staying within the Fed's old reduced target range, even as the Fed met to set a still lower target range … as if they cannot see their range means nothing if they cannot achieve it! Worse still, he says this has no implications for the economy or for monetary policy - even though the very monetary policy they were meeting to decide is supposedly something they labor over diligently because they believe it can stimulate the economy or slow it down. They even said they are lowering interest with this second cut in order to boost the economy as an insurance policy against economic headwinds, but he thinks people will believe him when he says the apparent failure of this interest rate to follow the Fed's dictates has no implications for the economy! And the scariest part of all? People did believe him!

Whew! That twisted my head more than the leaps and bounds in interest this week. It's the kind of flat and illogical response one gives when covering for a major crisis with banal assurances.

In other words, "Ignore the dead body on the sidewalk, Folks. Nothing to see here!"

Powell's prattle continued in order to explain the source of the problem,

This upward pressure emerged as funds flowed from the private sector to the treasury to meet corporate tax payments and settled treasury securities. To counter these pressures, we conducted overnight repurchase operations yesterday and again today. These temporary operations were effective in relieving funding pressures …

They were? See Day Two through Day Five above.

What I read from that is that the financial system doesn't have enough money left in it to handle relative ordinary and easily anticipated lurches in the economy's cash flow … but that won't won't affect the economy.

…and we expect the federal funds rate to move back into the target range.

Except that it didn't! Never mind. "Ignore that second body that just fell from sky, too, Folks. Move along. Your friendly Fed has this under control."

From elsewhere on this series of unfortunate events:

Investors were also watching the central bank's intervention in money markets on Wednesday to resolve unexpected liquidity issues. Major stock indices pulled back from their worst levels on the day after Powell said "It is certainly possible that we'll need to resume the organic growth of the balance sheet sooner than we thought," in response to the liquidity shortage. Though Powell stressed that balance sheet expansion would not be a resumption of quantitative easing. MarketWatch

Whoa! Powell admitted they may have to regrow the balance sheet. His "certainly possible" certainly tells you the Fed certainly won't be making that move in time, since they are only thinking of it at this late juncture as a future possibility. They also certainly won't be calling it "quantitative easing" this time around because that would cause everyone whose brain connection hasn't corroded from ten years of the Fed's fake recovery to ask why the last multiple rounds of quantitative easing for years failed to create a sustainable recovery as soon as the life support was removed and why we should think a return to that old program will yield any better results now.

Powell actually led off that statement above by admitting "there's real uncertainty" within the Fed when asked about the amount of reserves necessary for the world's most central banking system to function properly. There certainly is. If you put Powell's statement about real uncertainty within the Fed over where their balance sheet should be together with Bullard's statement at the top of this article that he thinks the Fed needs to rethink the way they think, it now becomes abundantly clear in the words of the Fed's own top officials, just as I've stated throughout the Fed's recovery program, that the Fed has no endgame. It never had one. It thought it would just tighten on autopilot, and all would be as Yellen claimed "as boring as watching paint dry."

As quoted from this St. Louis Fed president, quantitative easing may just be the new norm. That is why Powell can say it is not quantitative easing: if it becomes the new norm, then it is not easing, it is just the new everyday money supply! Hence, Powell couches the anticipated certainly possible move as "organic growth." It is just taking bank reserves up to the massively stacked levels we now need in order to keep functioning. It's organic in that it simply grows to meet the normal funding needs of the day for sustaining bank operations (as witnessed this past week) in an epoch of astronomical government debt and Fed-dependent markets. Organic.

Oh, but it will certainly possibly need to be done "sooner than we thought." Ahem. That sounds like they don't understand where they are. Who said all along you can count on the Fed to be too late in its thinking? How much sooner will they have to move than they thought? Have they rethought all of this in time if they are just now beginning to think about thinking it? This is like listening to the Keystone Cops.

Since all of this burst out as the Fed's FOMC was in its meeting, the Fed had little time to digest the repo actions, but Powell indicated it may have to make its certainly possible expansion of its balance sheet - let's just stay with calling it "QE4ever" - between now and its next meeting. In other words, it may certainly be possible that all of this will be a big enough deal that it cannot wait until the next meeting!

Call it what you want, Jerome, but the bottom line is that expanding your balance sheet in a massive enough manner to accomplish what the NY Fed's repo actions could not accomplish all week, is a quantitatively huge re-expansion of money supply in order to get it back up to what will be your new norm, and if you don't keep it there, you'll be right back to the same ruckus next time there is a series of unfortunate events. So, it is QE4ever.

By the end of the week ("Day Five" above), Powell's earlier statement that these were "temporary operations" that "were effective in relieving funding pressures" and that, as a result of their effectiveness, "we expect the federal funds rate to move back into the target range" morphed into…

The central bank said it would offer a series of daily and 14-day term overnight repurchase agreements, or repos, in the coming weeks for an aggregate amount of at least $30 billion each. It also announced daily repos for an aggregate amount of at least $75 billion each until October 10. Business Insider

Apparently a little less temporary. Still not QE, though, because we're still calling it "daily operations," not a permanent reinflation of money supply. Well, except that "daily" overnight loans have expanded into fortnight loans, and "temporary" has expanded to a month from now because those daily temporary operations have been working so well.

It's all going along quite splendidly. "Ignore all five bodies that have fallen around you, Folks. It may be raining bodies but we have this under control … in another couple of weeks … or more …"

… more in that, after this, the Fed will

"conduct operations as necessary to help maintain the federal funds rate in the target range, the amounts and timing of which have not yet been determined."

Oh my gosh. "As necessary" means "we'll keep doing this indefinitely if needed or in greater amounts and longer terms if needed." And the parrot press just kept mindlessly passing along the words it herd as if Powell's word is all we need, and as if there was no buried contradictions in what he said.

With almost $300 billion in overnight Fed infusions, we haven't seen Fed action on this scale since we plummeted into the Great Recession. Just shy of a third of a trillion dollars in overnight cash injections, but nothing to see here folks! Well, technically, they all had to be repaid the next day, so they probably do not total $300 billion now back in the economy, but that is not the case for the weeks ahead, when they will become fourteen-day loans.

Here is the Fed's new schedule:

Business Insider

Since the dailies expire in 24 hours and the next daily mostly rolls the last one over if needed. I see the minimum aggregate as being $75 billion on any given day plus ($30 billion x 3) = $165 billion for certain (no longer just "possibly certain") injected into the economy by the start of the third fortnight loan series on September 27th (just a week from now). But note those are all "at least" $30 billion, which is conditioned by Powell's "as necessary." So, it may be the least will be more as will what is necessary. Who knows?

But, it's no big deal. At least not unless the problem persists. Powell assured us at the start of all of this that it has no impact on the economy or on monetary policy. Just a daily dribble with the fortnighters being bigger in size than the $20-billion bailout loans that were made to banks at the start of the Great Recession. "Move along, Folks. It's all just the usual daily (now biweekly) rain of bodies from the sky. We've seen this before. Nothing to worry about."

Never mind also that these injections are happening as the Federal government passed the trillion-dollar deficit end zone this month while blowing past its former debt ceiling. That breach of the trillion-dollar deficit stratosphere is another thing I've been saying all year would happen this year, while others have been putting trillion-dollar deficits off until next year. All of this gives me more confidence the recession will eventually prove to have started on my summer schedule with Friday's launching of the Fed's new semi-permanent easing schedule - so reminiscent of the Great Recession as it is - being the last day of summer.

After all, during this final week of summer, it suddenly became consensus that …

The Fed has been slowly draining cash since the beginning of last year by shrinking its bond portfolio. The unwind was halted in July, earlier than scheduled. Powell signaled Wednesday that the Fed could soon return to expanding its balance sheet, a move that many analysts had predicted for next year. Bloomberg

Would those be the same analysts who have been predicting the recession will start next year???

Investors take for granted that the Federal Reserve controls interest rates. [Perhaps investors should stop doing that.] Rarely do they have to think about how. But a surprisingly lively couple of days in short-term money markets has meant that the "how" became nearly as important as the "why…." The New York Times

And that was only two days into this week's deluge of financial troubles at the central bank's core interest rate.

In the past, when the repo markets managed to make headlines, it was in exceptional episodes of market stress - for instance, in the early days of the financial crisis.

(Ah, the joy of reminiscing about the past on the final day of summer as I compose the first draft of this article.)

This time, there is little reason to worry that an economic catastrophe is in the offing.

And why would that be? Just because the Fed has told you, NY Times, there is little reason to worry? Would this be the same Fed that said after its FOMC meeting at the start of this week the problem had been taken care of? The same Fed that told you after you published this article that the operation will be continuing, in the very least, until October 10th? Ah, the gullible mainstream press that just parrots what the experts tell it.

At least, we are now all in consensus about the cause:

But in recent days, a number of factors had drained funds out of the market. Monday was a tax payment deadline for big companies and a holiday in Japan, which meant a large source of funds was shut off. And after a recent auction of government bonds, people had to divert cash to pay for those…. The amount of money pooled in this market has been declining for a while. And that's because of the Fed. Since 2018, the Fed has been shrinking its holdings of bonds and reversing its crisis-era policy of pushing money into the financial system…. The change has effectively reduced the supply of money available in the short-term lending markets…. "The problem is, we don't know what that minimum level is and we just smacked right into it," said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities USA.

Here is how I laid out in future tense in last January's Patron Post what the NY Times is now finally seeing in past tense, which we just smacked right into:

If the Fed continues to tell banks they must hold a certain ratio in reserves-to-loans as the most liquid form of protection against runs, then liquidity is going to tighten up if reserves fall, and interest rates are going to rise due to shorter supply of loans….

(For my patrons who want to reference this, the Patron Post where I pointed the problem out was "An Interesting Interest Conundrum." That was all about how those declining reserves were going to form the next financial crisis by causing the Fed to lose control of interest rates as bank liquidity would begin to seize up.)

Being fairly certain this was going to turn out to be the fault line over which the whole economy breaks, I recapped all of this in May shortly after interest started pushing the upper boundary (see the first chart above) in one of the regular articles on my site, titled "Liquidity Stress Fractures Begin to Show in the Federal Reserve System." (That article also includes the Patron Post's explanation of how IOER works for anyone wanting to know.)

Now here we are when the big cracks finally showed up in the final week of summer, when I expected the economy to start breaking apart into a recession.

Even The Times, having just said there was nothing to worry about, warns that, if the problem persists (as it did after the Times article was written and as the Fed now indicates it expects it to until, at least, Oct. 10) …

it could undermine the belief of those in the financial markets that the Federal Reserve can effectively apply monetary policy as it intends. The New York Times

Bear in mind how many times I've noted that belief in the Federal Reserve's ability to run the monetary system is really the only stock in trade the Fed has to sell. The Fed has said this, too. The entire value of fiat money rests on faith in its stability… as we've seen in every nation where that faith was broken that currency became what I call "wheelbarrow money" because it takes that much of it just to buy a loaf of bread.

"There is little reason to worry" about that, right? Why would people doubt whether the Fed is fit to "effectively apply monetary policy as it intends" when its big head stated unequivocally at the start of the week that all of this would have "no impact on monetary policy" - even though it turned into three more days of monetary policy as big as Great-Recession crisis management?

The main reason that the surge in the repo market has received attention is because it reminds people of the last time the market went haywire.

Uh … yeah. Is the NY Times now going to tell me this time is different?

If you ask me, all of this is exactly what the stress fractures at the start of a monumental recession look like. After all, even according to the New York Times, we haven't seen emergency financial crisis action like this… since the greatest financial crisis in nearly a hundred years:

In August 2007, the repo markets suddenly tightened, in what turned out to be one of the earliest indications that there were deep problems in the financial system.

And, yet, who recognized what those cracks meant in August 2007? No one I know of, including myself. I didn't recognize it until late November or December of 2007.

This time is different. No, really.

The surge in repo rates does not mean that investors now think Treasury bonds are risky.

How did I know that was coming? Seriously, before I even read down that far in the article, I had written all of the above.

And why exactly does it matter that "this time" does not mean investors think treasury bonds are risk? Do major cracks open up around the Fed's basement interest rate for one reason only - the same reason at the start of every financial crisis? I hardly think so. So, what how does it mean there is not a big problem here just because investor's don't think treasury bonds are the concern? There is a big problem, regardless of what is the primary mover.

Our assurance, says The Times, is none other than …

"While these issues are important for market functioning and market participants, they have no implications for the economy or the stance of monetary policy," the Fed chair, Jerome H. Powell, said a news conference on Wednesday…. Basically, the story of the repo market this week is essentially a hiccup for the technocrats at the central bank…. That's not great to see, but there is no reason to think this is the leading indicator of another financial crisis.

Ahh. Again with the bland repetition of Powell's assurance. It was all over the media.

Step in Bloomberg (and everyone else):

"The Fed just reminded the market that they have complete control over the front-end if and when they want it," said BMO Capital Markets strategist Jon Hill. "Given the volatility we saw this week, they want to ensure quarter-end goes as smoothly as possible." Bloomberg

Actually, since these extreme emergency measures have not been seen in more than a decade, and since they have not been working so far, I'd say they are strong evidence the Fed is losing control over this vital corner of the financial market, and the quarter-end is approaching as unsmoothly as ever seen. Can you imagine the greater year-end transactions in December if the Fed doesn't inject permanent quantitative easing in the meantime, especially as the US government continues on its trillion-plus deficit rampage, which is scheduled to continue as far as we can see?

The event awakened painful memories of the 2008 financial meltdown, when credit markets seized up suddenly as banks feared that borrowers would go bust before repaying. But after unveiling fresh cut to the benchmark lending rate on Wednesday, US Fed Chairman Jerome Powell told reporters the liquidity crunch was not a concern for the wider economy. "While these issues are important for market functioning and market participants, they have no implications for the economy or the stance of monetary policy," he said. MSN

Verified. All the major press coming back - even at the end of articles that clearly recognize how the outward signs of trouble match in severity to the first major cracks of the Great Financial Crisis - to just parroting the Fed. The Fed is giving the same kind of assurance it gave everyone in August of 2007. Thank God the Fed has assured us they have this under control!Bottom line:

This is bigger than what people are talking about. The Fed has been struggling to keep overnight rates down to their target rate for months, and this week overnight rates took off in a moonshot unlike any rate spike ever seen at this foundational level. The Fed hasn't even been able to wrestle those extremes back down after a week of trying. That means the Fed's statements last month and this that it is lowering rates are completely empty talk. Twice the Fed has lowered its target, while actual rates refused to comply with the target. They are not owning up to it (lest they cause all-out panic), and the mainstream media isn't smart enough to see it because their senses are dulled to accept whatever Grandpa Fed tells them.

Mere hiccups notwithstanding, I'll be continuing on all of this with quotes about where the Fed and its central-bank colleagues are taking us in the Patron Post that I am working on right now.

Original post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

The Fed controls short term interest rates only by actually intervening in the market and changing the conditions of supply and demand for money so as it hit its rate targets. Nobody has ever so much as pretended that the Fed could control interest rates *without* such intervention, and it is silly to call their needing to supply funds to hold the rate at their target "losing control". It is precisely how such control is actually exercised.

Yes the reason reserves are tight is broadly speaking that the Fed reduced its sheet size by $800 billion in its QT programs over the previous 2 years, ending in April. And ending early because they saw from the longer end of the bond market that they had already reached effective tightness well before excess reserves got to 0. It might also be fair to say that the Fed Funds market shows signs of atrophy from the long period, nearly 10 years now, in which no significant volume was lent and borrowed in that market because everyone who mattered had way more than enough reserves, thanks to previous QEs after the 2009 recession.

Money is tight at the present level of reserves. If that is news to anyone, they haven't been watching the bond market for a year.

Incidentally, the seasonal bit that I find under-reported in all the journalist level commentary on this topic is the increase in the US Treasury's general account balance at the Fed to $303 billion, which means it currently is holding about 18% of all reserves out. Treasury issuance in the last month totaled $250 billion; it has forced a large cash flow in its direction by that above normal run-rate issuance and is holding much of the proceeds in a higher general account balance. Some of that will reverse after the start of the new fiscal year as the Treasury issues checks; in the meantime it has represented a net new demand for direct Fed liabilities since roughly mid August.

It is still a matter of speculation, why the banks that still hold $1.1 trillion plus in excess reserves aren't eager to lend them on Treasury collateral themselves for a few extra basis points above what they can earn on their reserve balances at the Fed. Contrary to the author's comments, however, lowering IOR (E or not) certainly does make it more profitable for the banks that have those excess reserves to lend them to anyone who needs them, since their alternate return of just leaving them at the Fed pays 0.2-0.25% less than it did before that IOER cut.

There is still clearly demand for reserves, and likely some of the largest banks that have lots of the stuff also have, at this point, target comfort levels of those positions well above 0. Which is the same as saying Fed Funds can become objectively tight with non-zero legal excess reserves simply because not all excess reserves are actually "available" or likely to be offered by their present holders. They don't need to fear bankruptcy or problems with Treasury collateralized loans for that to be the case; it is enough if they have conventional and prudential reserve position size targets from day to day that they don't wish to go below.

The Fed is doing what it is supposed to do to maintain its rate targets and for that matter to act as lender of last resort to anyone offering sound collateral. That it is being forced to do so at this level or reserves and rates is indeed a clear sign that money is tight in a quantity sense - which should surprise no one at this stage of the cycle and after 2 years hard down on the quantity brake, with the long rate bond market results we've seen in the last year.

Will that past Fed tightness result in a US real GDP recession sometime in the next year to year and a half? All the odds from history say "yes". Late cycle full employment rate increases and quantity tightness always do result in a recession eventually, because in boom conditions business always overextends as though those conditions will last indefinitely - which gives us a business cycle in the first place. Nobody has repealed the business cycle; the Fed's job is only to manage them and try not to goose their amplitude by pro cyclical rather than anti-cyclical policy actions.

The Federal Reserve on Tuesday sold $105 billion in market repurchase agreements, or repos, in a continued effort to calm money markets and bring interest rates within its intended range. The bank offered $75 billion in repos expiring overnight and $30 billion in repos expiring in 14 days. Banks bid for more than was available of each repo, signaling strong demand for the government-backed asset. The bank began a streak of repo offerings last week, marking the first time such assets were sold since the 2008 financial crisis. The central bank said the offerings would continue through early October. Visit the Markets Insider homepage for more stories.

The Federal Reserve added $105 billion to the nation's financial system on Tuesday in two transactions, seeking to calm money markets and keep interest rates in its intended range.

The New York Fed continued its streak of market repurchase agreements, or repos, selling $75 billion of overnight repos and $30 billion of repos expiring in 14 days. Banks bid for $80.2 billion in overnight repos and $62 billion in 14-day repos, signaling strong demand in the government-backed investments.

Last week marked the first time in a decade that the bank had taken such steps to relieve pressure on money markets. The bank offered a total of $278 billion in repos from Tuesday through Friday.

Also last week, the Federal Open Market Committee cut its benchmark interest rate by a quarter of a percentage point, landing in a window of 1.75% to 2%. Fed Chairman Jerome Powell called the repo offerings a temporary action.

"Funding pressures in money markets were elevated this week, and the effective federal funds rate rose above the top of its target range," he said.

The Fed's schedule calls for another $75 billion of overnight repos to be sold every business day until October 10, with certain days also offering at least $30 billion worth of 14-day repos.

Recent turbulence in U.S. money markets has cast light on a big problem hidden at the root of the Federal Reserve’s conduct of monetary policy: It is targeting an increasingly irrelevant interest rate.

Less than $100 billion changes hands each day in the federal funds market, the overnight interbank rate that the central bank targets. In contrast, considerably more than a trillion dollars are traded daily in the market for repurchase agreements, where financial institutions swap Treasury securities for cash.

“Fed funds is a moribund market,” said Mark Cabana, head of U.S. interest rates at Bank of America Corp. “It does not really represent where banks are truly seeking to lend and borrow.”Turnover in the fed funds market is on the decline

That’s led to calls that the Fed change its framework for carrying out monetary policy. The aim: Lessen the chances of the sort of turmoil that saw repurchase or repo rates soar as high as 10% last week and strengthen the central bank’s control of the short-term money markets that underpin the financial system and the economy.

The most radical step the Fed could take -- and probably the one that’s least likely at this point -- would be to junk the fed funds target entirely and replace it with an objective for an economically more significant short-term rate.

Among the possible candidates to replace fed funds: The recently minted secured overnight financing rate, a broad daily repo rate measure that the Fed is championing as a new benchmark for contracts on everything from home mortgages to corporate loans. One downside is that, being linked to repo, it too was subject to major spikes during the recent tumult.

A more subtle, yet still potentially significant change that the central bank could make would be to tweak the rules of engagement under which the New York Fed’s Open Market Desk operates in the money market. Instead of being tasked to merely keep the federal funds rate within its target range, the desk could be given greater leeway to respond to pressures elsewhere in the money markets.

While some analysts say the desk may be indirectly doing that already, a more explicit mandate would reassure traders that the Fed is ready to respond promptly to market dislocations even when the funds rate is within its target range.

Repo Market’s Liquidity Crisis Has Been a Decade in the Making

Speaking to reporters on Sept. 18, Fed Chairman Jerome Powell played down the significance of recent market strains, though he acknowledged that they had been worse than expected.

“While these issues are important for market functioning and market participants, they have no implications for the economy or the stance of monetary policy,” he said.

Before the 2008-09 financial crisis, it made sense for the Fed to target the federal funds rate because that was the market banks used to lend and borrow scarce reserves from each other, with hundreds of billions of dollars changing hands each day.

The market’s dynamics changed, however, when quantitative-easing measures intended to safeguard the economy created vast new bank reserves, lessening the need for institutions to tap interbank liquidity. While some of those reserves have since been extinguished, there are still far more than there were pre-crisis.

That’s left the Federal Home Loan Banks -- a group of government-sponsored lenders -- as the dominant players in the fed funds market, unintentionally giving them outsized influence over where the rate settles.

“It’s too specialized and too small a market,” said Joseph Gagnon, a former Fed official who is now a senior fellow at the Peterson Institute for International Economics. “You want a bigger market” to use for a target.

Read more: The Death of Fed Funds? As Market Dries Up, FOMC Asks What Next

Fed policy makers discussed alternatives to the funds target at their policy making meeting last November. One that got a lot of air time: The overnight bank funding rate.

Published by the New York Fed, the unsecured benchmark adds eurodollar transactions -- which are largely banks borrowing from non-bank financial institutions, like money-market mutual funds -- and certain domestic deposits to the volume of daily fed funds transactions.

While OBFR volume is roughly double that of fed funds alone, it is still just a fraction of that in the repurchase market. And it also has been trending lower in recent years.Rates Primer:

The federal funds rate is the interest rate that banks charge each other to borrow overnight and is the rate the Fed targets to guide the cost of borrowing in the economy. A repo or repurchase agreement is a pact by which firms borrow cash from each other by putting up securities such as Treasuries as collateral. When the agreement expires, the borrower “repurchases” the collateral and returns the cash. SOFR or the secured overnight financing rate is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. The Fed is promoting SOFR as a benchmark for loan contracts. The overnight bank funding rate is a measure of wholesale, unsecured, overnight bank funding costs. It is calculated using federal funds transactions, certain Eurodollar transactions, and certain domestic deposit transactions.

Some policy makers at the November meeting “saw it as desirable to explore the possibility of targeting a secured interest rate,” according to the minutes of the gathering.

Peterson’s Gagnon supports targeting the secured overnight financing rate, or SOFR. One ancillary benefit of doing so: It might reassure borrowers and lenders that SOFR will be relatively stable and so make them more likely to adopt it as an alternative to the beleaguered London inter bank offered rate.Big Spike

The recent turmoil -- which saw SOFR more than double to 5.25% on Sept. 17 -- has raised questions among some market participants about its suitability as a benchmark.

Adoption of a SOFR target though would have some other downsides. It could open up the Fed to accusations that it is protecting hedge funds and other financial institutions active in the repurchase markets, said Scott Skyrm, executive vice president at broker-dealer Curvature Securities.

The central bank may also find it harder to keep the rate within its target range than has been the case with fed funds.

“There’s no perfect substitute” for the current target, said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities.

A lot of people on here don’t seem to understand what a financial repo market is, or why it’s so important, so here’s an explainerSeptember 19, 2019 by IWBvia MUGATU:

Hedge Funds, Bank CEOs, etc own assets like bonds, etc but need cash in the near term to buy necessary things like boats, cars, mansions, 14 year olds, etc That business is so large that on a dollar basis it’s the most significant base of transactions in the United States. But sometimes Billionaires run short on cash, so they borrow some from their friends at the Fed, the Treasury, or the Illuminati Grand Pyramid / Bass Pro Shop When the Bass Pro Shop runs out of money to lend and Bill Ackman owes money to Dan Loeb who owes money to Ken Langone at the same time, they all don’t have enough cash to buy their standard daily Lamborghini (single use, they got gross after 2-3 rides) So at this point the Fed has to repossess a lot of the cars, mansions, and 14 year olds, or else we might run out and then the economy would collapse. What the Fed does is take those things that they “repo’ed” and sell them to the drug companies, who come up with money from poor people trying not to die from poor people problems like kidney failure or non helicopter-oriented vehicle crashes. Warren Buffett famously does not buy lambos because he has that kidney money, so he gets them for free from the Fed and the Bass Pro Shop, and then he sells the lambos later to fund Charlie Munger’s crippling peanut brittle addiction. Trump is mad at Powell because he wanted a cut of the repossessed real estate and a right of first refusal on the Eastern European 14 year olds, hence his tweeting. Powell works for the Fed, which answers only to The Bass Pro Shop as it is an independent entity. The reason you buy gold when the Fed enters the market is because they drain the supply of lambos, meaning the Middle East And Russian big money guys coming to the UN thing next week will have buy gold coins to throw in the river and watch poor people dive for for fun. This is the basis for all FX trading, not just gold, when you break it down to the essentials. I hope this has been helpful.

I know exactly what you mean. Let me tell you why you’re here. You’re here because you know something. What you know you can’t explain, but you feel it. You’ve felt it your entire life, that there’s something wrong with the world.You don’t know what it is but its there, like a splinter in your mind

Photographer: Eva Hambach/AFP/Getty ImagesBrian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.Read more opinionFollow @BChappatta on TwitterCOMMENTSLISTEN TO ARTICLE5:13

The repo market madness lives on for a ninth day.

The Federal Reserve Bank of New York announced Wednesday that it would increase the size of its next overnight system repurchase agreement operation to a $100 billion maximum, from $75 billion previously, and also raise the limit on its 14-day term repo operation to $60 billion from $30 billion. Simply put, the bank wants to flood the funding market with enough cash to soak up all the securities that dealers submit 1 and leave no doubt that the critical financial-system plumbing is in fine working order ahead of the end of the quarter.

By now, just about everyone has heard the explanations for this persistent liquidity squeeze, which has lasted long enough to refute the earlier notion that it was merely a one-day confluence of unfortunate events. To some, the main structural issue is that banking regulations are disrupting the financial system’s inner workings. Others say the Fed has simply found the lower bound for reserves necessary to control short-term rates and can move forward accordingly.

In addition to those two assessments, I’d offer another angle that’s largely flown under the radar: The chaos in repo markets was a long time coming given the widening U.S. budget deficits and the lenders that are financing that shortfall.

Deficits, while nothing new, add up over time. And while they declined each year from 2011 through 2015, both overall and as a percentage of gross domestic product, the gap has widened again under President Donald Trump. Put it all together, and the amount of U.S. Treasury securities outstanding has roughly tripled since the financial crisis:Bountiful Bonds

U.S. deficits since the financial crisis have tripled the amount of Treasuries

Source: Federal Reserve

This growth was mostly under control in the years after the financial crisis because the Fed had been buying up large chunks of the Treasury market through its quantitative easing programs. But it was gradually reducing the size of its balance sheet from late 2017 until July, precisely at the same time that the Treasury Department was increasing the size of its monthly auctions to finance the bigger budget shortfalls. All told, the Fed now holds about $2.1 trillion of Treasuries, down from almost $2.5 trillion previously:Pulling Back

The Fed was slowly reducing the size of its balance sheet since late 2017

Source: Federal Reserve

The Fed remains the largest single holder of Treasuries. But combined, Japan ($1.13 trillion) and China ($1.11 trillion) own more. And yet, even with those huge stakes, the two countries haven’t been keeping up with the growth in the world’s biggest bond market. In fact, on a percentage basis, Japan’s U.S. Treasury holdings are close to the lowest in at least 20 years, while China’s are the lowest since mid-2006:Not-So-Insatiable Appetite

China and Japan aren't buying Treasuries as fast as the U.S. is selling them

Source: U.S. Treasury

So if it’s not the Fed, it’s not China and it’s not Japan, where are all these Treasuries going?

U.S. commercial banks are certainly a place to start looking. They’ve done their part since the financial crisis, but especially lately, with holdings of Treasuries and agency securities climbing to almost $3 trillion as of Sept. 11:Doing Their Part

U.S. commercial banks have amassed a record amount of ultra-safe debt

Source: Federal Reserve

Primary dealers, a select subset of banks that are obligated to bid at Treasury auctions, were saddled earlier this year with the most Treasuries ever — an outright position of almost $300 billion. Even now, their holdings are more than double what they were a year ago as they’re required to take down larger pieces of the U.S. government’s debt sales.

There are simply too many bonds (or, in the language of the repo market, “collateral”) sloshing around in the financial system and not enough cash on the other side of the trade. America’s budget deficits are being financed domestically and leading to a relentless drain on reserves:Cash Drain

Reserves at the Fed have fallen to the lowest level since 2011

Source: Federal Reserve

All this goes to show that fiscal stimulus — which I’ve argued that bond markets are begging for — doesn’t quite work by itself. Without the Fed helping to finance deficits by accumulating Treasuries, the financial system seems doomed to seize up. Someone has to take what the Treasury is offering, and given that the 24 primary dealers are by definition the buyers of last resort, it falls on these critical institutions to pick up the slack.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said that the banks “have a tremendous amount of liquidity but also have a tremendous amount of restraints on how they use that liquidity.” As former Minneapolis Fed President Narayana Kocherlakota wrote for Bloomberg Opinion, requirements like holding a certain amount of liquid assets and maintaining a minimum leverage ratio, which sound perfectly reasonable in theory, can distort lending and borrowing in unforeseen ways.

Boiling down the New York Fed’s repo operations to their most basic level, the central bank is effectively coming into the market every morning, taking excess securities from dealers and giving them cash instead. This is a quick fix to offset the liquidity imbalance, but it’s not a permanent solution. Fed Chair Jerome Powell said last week that it’s “certainly possible that we’ll need to resume the organic growth of the balance sheet earlier than we thought,” and indeed it seems likelier by the day that policy makers will announce such a move by their next interest-rate decision on Oct. 30.

Wall Street strategists have gone to great lengths to say that such organic growth is not QE. I’m fine with that distinction. But ultimately it comes down to the fact that the Fed seems to have little choice but increase the size of its balance sheet in the face of trillion-dollar budget deficits, whether in good economic times or bad ones. U.S. banks can’t afford to have the Fed out of the market entirely.

The financial system, as it is today, is choking on Treasuries. And only the Fed can perform the Heimlich.

By contrast, the New York Fed wasn't able to do that on Wednesday. Its overnight repo operation was oversubscribed as dealers submitted about $92 billion of securities, but it only took $75 billion.

Ballooning Treasury auctions have placed a heavy burden on the financial system, forcing the Fed’s hand.//Deficits, while nothing new, add up over time. And while they declined each year from 2011 through 2015, both overall and as a percentage of gross domestic product, the gap has widened again under President Donald Trump. Put it all together, and the amount of U.S. Treasury securities outstanding has roughly tripled since the financial crisis:

One of the more chilling articles I've read here. It sounds like the Fed may be running out of air to blow that balloon. But then they can create credits out of thin air. But this is a hell of a moment.

Ballooning Treasury auctions have placed a heavy burden on the financial system, forcing the Fed’s hand.//Deficits, while nothing new, add up over time. And while they declined each year from 2011 through 2015, both overall and as a percentage of gross domestic product, the gap has widened again under President Donald Trump. Put it all together, and the amount of U.S. Treasury securities outstanding has roughly tripled since the financial crisis:

One of the more chilling articles I've read here. It sounds like the Fed may be running out of air to blow that balloon. But then they can create credits out of thin air. But this is a hell of a moment.

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The editorial board 14 hours agoPrint this page20

When commentators want to describe the abstract world of finance they reach for water-based metaphors: capital “flows” around the system, while assets face selling “pressure”. Last week, the cost of short-term funding in the overnight money market surged upwards. Many have wrongly dismissed this rise as merely a technical issue with the market “plumbing”.

Turmoil in the repo market raises concerns about the operations of the dollar funding market and the US banking system. Almost two weeks after the episode, normality has just about returned to the money markets, the wellspring of the world’s financial system. Dodgy plumbing can quickly undermine the whole foundation.

The repo market allows banks and investors to exchange high-quality assets, usually US government bonds, for short-term cash funding. Borrowers then repurchase the assets for a slightly higher price at an agreed date, usually the next day, creating what is in effect a short-term loan. The market lets banks meet their short-term funding needs and is essential for the smooth operation of the dollar-based financial system. It seized up during the financial crisis in 2008.

No one fully understands exactly why the market froze suddenly last week. Many explanations centre on a sharp increase in demand for liquidity partly in order to meet corporation tax payments and the US Treasury department increasing its own cash pile in order to fund spending.

Others point to an increasing concentration of excess bank reserves in the hands of just a few players while the Federal Reserve tries to shrink its balance sheet after a decade of extraordinary monetary policy. Just four banks, JPMorgan Chase, Bank of America, Wells Fargo and Citigroup, have much of the excess dollar bank reserves.

The New York Federal Reserve, the branch of the central bank that takes much of the responsibility for the functioning of the US financial system, stepped in to provide more cash to the market the day after the spike. It also held a two-week repo auction this week to help alleviate funding pressure over the end of the quarter, when banks sometimes step away from short-term lending. Yet many in the market suggest the episode exposed deficiencies in the NY Fed’s ability to act as a steward of the financial system.

It comes at an unfortunate time for John Williams, director of the NY Fed, who has had to recently reorganise the markets section of the central bank. Simon Potter, head of the NY Fed’s markets group with 21 years experience, recently left the team along with Richard Dzina, the head of the financial services group. Some market participants ask whether Mr Williams, an economist by background, has the necessary experience to handle the crisis.

Others suggest it shows a more fundamental problem with the banking system. Interest rates on offer in the repo market touched 10 per cent during last week’s upheavals. But this was not enough to tempt lenders to increase supply, despite excess reserves only earning 1.8 per cent when deposited at the Federal Reserve. That reflects that bankers now see a greater need to have cash on hand to meet the regulatory requirements imposed on them since the financial crisis.

This all means the funding system will be more prone to these kind of rises than in the past and banks will have less capacity to act as a shock absorber. Instead, the Fed may find it needs to resume some form of asset purchases far earlier than it might feel comfortable with in order to keep lending flowing. Central banks need to get used to the new normal.

So, RE, you are the finance wizkid. Explain to me a mere bio major/lawyer. I read all the above posts on the repo crisis. Isn't the Fed's response just to start QE again. Just print as much fiat money out of thin air to buy all those treasuries that the government needs to sell to finance the exploding deficits? Just inflate the money supply to the moon? Is that what the market wants? And for all those people on Wall Street, do they ever see a problem in that? How does it crack and break? Don't all those Treasury bonds (that are the world's safest investment) someday/somehow become worthless electronic numbers?AJ